MARKET PLACE

MARKET PLACE; Google's Offering Proves Stock Auctions Can Really Work

By FLOYD NORRIS

Published: August 23, 2004

It worked. Google's auction process, both criticized and feared on Wall Street, could have gone much more smoothly, and investors might yet regret putting money into a company that plans to go its own way regardless of what others think.

But the fact is that Google managed to go public at a very attractive valuation -- many times higher, for example, than the price Microsoft fetched when it went public in 1986 -- and to give Wall Street a surprisingly small piece of the action in doing so.

It was not so much that the fees paid the investment bankers were lower than normal, although in an offering of this size, the percentage point or so that was saved amounted to $16 million. It was that being a friend of the underwriter was of no help in getting in on the initial profits from the new offering.

Those profits turned out to be substantial, even if they were small by the traditions of the late 1990's, when Wall Street was able to use allocations of hot initial public offerings as currency to inflate its profits far beyond the reported fees. Underwriters used the profits to force investors to pay high commissions on ostensibly separate trades, and they used them to curry favor with politicians and corporate bosses who could send future business their way.

It is appropriate that there be some profit in initial offerings. Buying a new stock means paying a price that is not clearly a market price. But the profits grew excessive in the boom years. Where a profit of 15 percent was once considered reasonable, and one of 30 percent or more extraordinary, gains of 200 percent or more came to be expected. The record, which will probably stand for some time, was a 698 percent rise on the first day of trading for VA Linux in December 1999.

During the boom, the favored few who received allocations generally sold quickly, leaving the company with a base of shareholders who paid far more than the company received and were likely to be disappointed in the long run.

Google's Dutch auction was intended to assure that anyone who wanted to get in could -- at least in the United States, as the offering was not registered overseas. That led to fears that the price could plunge the first day, but it did not. It appears the company and the underwriters priced it low enough to ensure an increase, and the price rose by 18 percent the first day and ended Friday 27 percent above the offering price of $85.

One expectation was that the unorthodox approach would result in less flipping of shares the first day, since the buyers presumably really wanted the stock, as opposed to just wanting to get in on a hot offering that was expected to leap in value the first day.

That expectation was realized, but not to the extent some anticipated. Volume over the first two days of trading equaled 172 percent of the shares sold in the offering, not far from the 166 percent when Microsoft went public in 1986, or the 184 percent of America Online's offering in 1992. That is high, but way below the figures recorded as technology stocks grew hotter in the 1990's. In 1996, Yahoo volume the first two days came to 784 percent of the shares offered.

Google has sought an anti-Wall Street image, both by conducting the auction and by saying it will not play the Wall Street game of estimating quarterly earnings. It did not provide earnings forecasts at the road show, where favored institutional investors traditionally get to hear forecasts not shared with the general public.

The Securities and Exchange Commission has long allowed such activity as long as nothing was put in print, and so it is ironic that the S.E.C. became upset with Google because its founders gave an interview to Playboy that appeared just as the auction was about to be completed. That interview had far less to say than the typical road show, but it was in print.

The S.E.C. allowed the offering to proceed, but the prospectus disclosed that the commission was seeking additional information, which presumably means the enforcement division is interested. That division is already asking questions about the way Google issued options to employees and others without registering them. It has also told Google's general counsel that it is considering bringing a civil fraud suit against him for his role at SmartForce, a software company he served as chief financial officer. Three separate S.E.C. inquiries affecting a new issue may be a record.

One thing that is remarkable about Google is how large the offering was, compared with many previous ones. Consider six previous offerings of new technology companies, all highly publicized at the time and all successful in the market for some time, though not necessarily for long. Between them, Microsoft, America Online, Netscape, Yahoo, Amazon.com and Priceline.com raised $470 million, barely a quarter of the $1.67 billion Google investors plunked down at the offering.

In 1986, Microsoft's offering price valued the company at three times revenues in the previous 12 months, and 16 times earnings. The figures for Google were 10 times revenues and 85 times earnings.

The high valuation accorded Google means that it will have to grow at a strong pace for many years to come to justify the prices being paid, and the sheer size of the $29.7 billion market capitalization it has will make that growth even more impressive if it does come.

Google's auction process was messy, and the reduction of the expected offering price may have scared away some investors. But it worked well in the end, and may persuade other companies to try something similar.